Why Kansas City Southern’s (NYSE:KSU) High P/E Ratio Isn’t Necessarily A Bad Thing

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Kansas City Southern’s (NYSE:KSU) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Kansas City Southern has a P/E ratio of 21.4. That corresponds to an earnings yield of approximately 4.7%.

See our latest analysis for Kansas City Southern

How Do I Calculate Kansas City Southern’s Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Kansas City Southern:

P/E of 21.4 = $123.64 ÷ $5.78 (Based on the year to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Kansas City Southern saw earnings per share decrease by 37% last year. But EPS is up 13% over the last 5 years.

Does Kansas City Southern Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Kansas City Southern has a higher P/E than the average (17.8) P/E for companies in the transportation industry.

NYSE:KSU Price Estimation Relative to Market, May 3rd 2019
NYSE:KSU Price Estimation Relative to Market, May 3rd 2019

That means that the market expects Kansas City Southern will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Is Debt Impacting Kansas City Southern’s P/E?

Net debt totals 22% of Kansas City Southern’s market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Bottom Line On Kansas City Southern’s P/E Ratio

Kansas City Southern trades on a P/E ratio of 21.4, which is above the US market average of 18.1. With modest debt but no EPS growth in the last year, it’s fair to say the P/E implies some optimism about future earnings, from the market.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

But note: Kansas City Southern may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.